Infected deals: M&A in times of Covid-19

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Infected deals: M&A in times of Covid-19


Authors / Rapporteurs

Paul A Josephus Jitta
Buren, The Hague


Charles Martin
Macfarlanes, London



Paul A Josephus Jitta
Buren, The Hague

Charles Martin
Macfarlanes, London



Dinesh Melwani
Mintz, Boston

Ralf Morshäuser
Gleiss Lutz, Munich

Luciana Tornovsky
Demarest Advogados, São Paulo

Seiichi Okazaki
Mori Hamada & Matsumoto, Tokyo


During the webinar a panel of very experienced, highly ranked M&A lawyers from relevant jurisdictions, such as Brazil, Germany, Japan, the United Kingdom and the United States, shared their recent experiences and further expectations about the effects of Covid-19 on pending, done and future deals. The panel discussion was initiated and moderated by Paul A Josephus Jitta, a Dutch M&A lawyer, partner at Buren in The Hague and a member of the Closely Held and Growing Business Enterprises Committee (CHAGBE). The co-moderator was Charles Martin, a former senior partner at Macfarlanes in London and a member of the Corporate and M&A Committee.

Outcome survey

Josephus Jitta revealed the outcome of the pre-webinar survey of participants. Apparently 85 per cent of the more than 500 participants had already experienced an infected deal; one-third of the deals was postponed, but the majority of the deals were being closed despite Covid-19. A vast majority of 70 per cent of participants expected an increase in litigation related to M&A in the near future. About one-third of all participants made use of innovative solutions, technology or tools to mitigate the effects of Covid-19 on the transaction at hand.

Pending deals

Contractual tools

Starting with pending deals, which were signed but not yet closed, according to Martin, a possible contractual tool for a buyer to bail out of the transaction would be the material adverse change (MAC) clause. However, this is not a very commonly used clause in the UK market. Other tools could be: warranties breached (as compared to the signing date, during the period between signing and closing or when repeated at closing); breached interim period provisions; nonfulfilment of conditions precedent; and strict compliance with closing obligations and deliverables.

            Martin explained that warranties may be breached now as a consequence of the impact of Covid-19 on the target’s business. Yet quite likely will also be a breach of the provisions that require the seller to run the target’s business in the ordinary course with the pandemic going on. In addition, very promising for a buyer would be the potential nonfulfilment of conditions precedent, like obtaining antitrust approvals before the agreed long stop date.

            Last but not least, it can be expected that buyers shall require strict compliance by sellers with closing obligations and closing deliverables, as the nonfulfilment thereof might give the buyer the right to walk away.

            Luciana Tornovsky, a well-known Brazilian M&A lawyer of Demarest in São Paulo and secretary of the CHAGBE, explained that an MAC clause could allow buyers to terminate the agreement before closing in the event of extreme, exceptional events that compromise the rationale of the transaction. According to Tornovsky, it is important to check if there are any exceptions to applying an MAC clause. A recent international transaction affected by the Covid-19 outbreak is Carlyle Group and GIC investing in AMEX Global Business Travel. Investors were invoking an MAC to exit the investment. They argued that an MAC had occurred as diminished demand decreased the company’s value. However, the agreement did not have any type of language about a potential pandemic. After going to a Delaware court house, the case was settled.

            Tornovsky set out that, under Brazilian law, a force majeure event must be supervenient to the agreement. There must be a cause-consequence relation with the damage incurred or non-performance of the agreement and the fact that such event could not be avoided or mitigated. Unexpected events may also lead to the discussion of excessive onerousness of the contract. In such an event a significant change in the contractual obligations is required because otherwise one of the parties would bear a much greater economic sacrifice then the expected risk of the contract.

            At present there is a Brazilian bill of law establishing that an increase in inflation, exchange rate fluctuations or currency devaluations cannot be considered as a force majeure event or causing excessive onerousness of the agreement. This bill of law is still waiting for presidential approval, so according to Tornovsky it is still uncertain if and when it will come into effect.

Changing deal terms

Dinesh Melwani, an American M&A lawyer, a member of Mintz in Boston and the CHAGBE North American Regional Forum Liaison Officer, has already seen changing deal terms, as valuations of target companies are affected. He expects that more earn-out mechanisms will be used. Businesses are obviously suffering a sizeable impact both in terms of their actual sales and also in their future projections. Due to Covid-19, valuations are being renegotiated. There are limitations now to using historical financial data to project future performance. Buyers are adjusting their estimates and obviously want to build in additional cushions to account for the economic consequences. When Melwani is representing sellers, he is trying to bridge to the gap in order to get the deal done. He expects that earn-out mechanisms will gain importance, though they always have complexities regarding post-closing covenants. However, sellers and buyers now are really desperate to find a way for the right valuation.

            Ralf Morshäuser is a German M&A lawyer based in Munich, the co-head of the M&A practice at Gleiss Lutz and the Membership Officer of the Corporate & M&A Committee. He sees as the most remarkable development the massive turn from a seller-friendly market to a buyer-friendly market or, even beyond that, what he calls a ‘struggling’ market. This boils down to purchase price elements and valuation topics. Morshäuser expects that ‘locked-box’ clauses are completely out now because they are related to former effective dates. He also expects heavy discussions on closing adjustments using normalised working capital, as what is normalised in times of Covid-19? Melwani agrees and says that this also applies to the US market.

Impact on due diligence

Covid-19 is also clearly affecting due diligence. According to Morshäuser, this applies both to sellers setting up a data room and to buyers performing their due diligence reviews. Everything that Covid-19 can affect commercially will be automatically also be a due diligence item. As an example, a single source supplier or a business depending on only a few customers can seriously affect the target’s business outlook. Other important issues might be compliance with Covid-19 crisis plans and with labour law during lockdowns. There is, however, not a general rule to apply in due diligence. One should consider where Covid-19 affects the target’s business and be aware of this both in setting up the data room and in performing a due diligence review.

            Seiichi Okazaki is a Japanese M&A lawyer at Mori Hamada Matsumoto in Tokyo and the CHAGBE Communications and Publications Officer. He says that Covid-19 can have an endless impact on the list of topics to investigate during due diligence. He addresses two specific things. The first is the depth and scope of the due diligence. For a contract review, for example, obviously just looking at the contract in the data room would be not enough because you need to verify if there is contract renegotiation taking place now, or whether or not performance deadlines are being met. You should look sufficiently deeper into those ongoing and changing circumstances that may not be formalised in writing yet. Second, he says that Covid-19 reminds us that law differs from one jurisdiction to an other. Everybody knows that force majeure will be an issue when you do due diligence, but obviously this depends on the governing law and local practices. Local default rules, in addition to what is written in the contract, are likely to become a relevant circumstance to the contract analysis. In Singapore, for example, a new law has come into effect to suspend legal enforcement of certain categories of contracts. If the target is doing business globally it is even more important to work with local counsels now.

Impact on W&I insurance

According to Melwani, increased scrutiny is part of what we are living with now, not only at the side of buyers but also at the side of insurers. What can be excluded from these policies becomes pretty much standard procedure in many of our large M&A deals. As insurers are getting more and more aggressive and familiar with the space, even in smaller deals it can be expected that they start adding broad exclusions for business interruptions or losses related to Covid-19. It is the responsibility of counsel to help to narrow those exclusions, because it will be difficult to determine what is directly or indirectly related to the pandemic. As W&I insurance has ballooned in M&A in recent years, there are more players in the market today. There will be fewer deals, however, so insurers cannot raise the exclusions bar too high. W&I insurance will stay, but if buyers cannot get sufficient coverage we may see resurgence of escrow mechanisms.  

            Tornovsky agrees. Insurance companies are proposing exclusions related to the exposure of the pandemic. The parties should be prepared to discuss the target’s conduct on potential Covid-19 impact, purchase agreement provisions that protect the buyers from any related risks and any factors that could mitigate the impact of Covid-19 on the target’s business. Contractual provisions around determination of material adverse change, related representations and warranties and interim period operating covenants will undergo scrutiny by insurance companies. On deals already signed but not closed, according to Tornovsky insurance companies are more frequently asking questions to determine the buyer’s understanding of the impact that Covid-19 has on the target’s operations, facilities, employees and suppliers. Breaches of interim period covenants are often excluded from W&I policies.

Changing attitudes of governmental bodies to foreign buyers?

According to Martin it is still early days clearly but the European Commission came out asking parties to hold off making merger control applications. The UK Competition and Markets Authority confirmed that timetables remain unaffected. The UK government is entitled to intervene in foreign investment where there are public interest issues. In 2018 the scope of that was already broadened in the tech sector. Proposals for giving government much greater power to intervene on issues of national security can be expected.

            More recently the EU Commission came out really early in response to some US interest in German pharmaceutical companies, urging Member States to be very careful and restricting acquisitions in the healthcare sector. The German cabinet approved proposals in that respect, as did Poland among other European jurisdictions. The European Commission also urged Member States to think about state building where necessary to deal with unwelcome state building by foreign entities. It is hard to predict how that will work out, given restrictions on golden shares and state aid.

            In the US the Department of Defence urged the active use of Committee on Foreign Investment in the United States reviews where ‘adversarial’ capital is coming into the market. This is going to restrict acquisitions in technology, infrastructure and data companies. Overall, Martin expects that countries will promote the creation of national champions coming out of this crisis. The attitude of regulatory authorities in that regard is going to be interesting. Before the crisis the European Commission was reluctant to deal on the basis of vague intimations of competitive threats, from China, for example, like in the Siemens-Alstom case. They will also be scrutinising carefully the use of ‘failing firm’ defences. Competition regulators will be concerned that the crisis will force weak competitors into the hands of even stronger ones. They might be rather more prepared to see those weak competitors being sold and then broken up than to create problems down the line.

            Okazaki does not see a change in antitrust rules in Japan as a direct result of Covid-19, but says it is likely that there will be an increase in transactions to rescue struggling companies. It is also likely that governments will not see such company-saving transactions as being anticompetitive. Regarding foreign investment, like other jurisdictions, Japan has significantly expanded the scope of foreign investment review. For example, acquisitions of one per cent or more in Japanese listed companies require governmental approval and a waiting period. Yet this is not a direct response to Covid-19. As a direct response to the crisis, like other jurisdictions in Europe, the Japanese government has expanded the scope of foreign investment duties to include medical devices such as ventilators and certain other medication that is applicable to infection diseases such as Covid-19. It seems that many jurisdictions are taking similar approaches in respect of medical devices and medicine.

Participants’ poll: more earn-outs

A live poll taken during the webinar showed that a huge majority of the participants expects earn-out mechanisms to become increasingly important again.

Future deals

Private equity will be first movers

Tornovsky points out that not all industries are harmed by Covid-19. Clearly, industries such as tourism, travel and automotives are critically affected, but health services, distribution, logistics, supermarkets, drugstores, e-commerce, telecom and online applications are doing relatively well. The interest of investors in distressed assets will increase. Private equity funds are most likely to be the first movers. As they are quicker players in the market they will find the best opportunities, likely in the second part of this year. Private equity players that recently closed a fundraising cycle can act swiftly now. Valuations are going down and the market is depressed. According to Tornovsky, Brazil has some advantages compared with other countries, such as its large market with strong potential for growth, its important agriculture sector, infrastructural investment promoted by governments, private investment in public equity  and affordable exchange rates for foreign investors.

Vertical integration and further digitalisation

According to Martin, resilience will be top of mind at the boards of large corporates. One can expect the integration of supply chains and vertical integration generally. Also, the pace of digitalisation is going to accelerate and digital strategies will gain importance. Shareholders influence may increase. In the UK market there are already signs that shareholders are deciding which management teams they want to back with capital and with their voting support. If a company does not have such support, it may potentially be one of the public-to-private targets that Tornovsky mentioned.

            Martin expects that balance sheets are going to be less leveraged going forward. That means reduced debt but potentially also disposals to raise cash. Corporates can be expected to be looking at spinning out to private equity houses entire divisions as an alternative for raising capital. Finally, the number of ‘share-to-share’ deals will increase. Martin predicts increasing consolidation, which will also result in more share merger proposals.


The discussion moved on to in which industries the best opportunities will rise. Melwani’s favourite is education technology (Edtech). According to Melwani, the pandemic proves that we need to find a way to continue education because it can no longer be via the traditional model of walking into a classroom. There are some great tools out there and he thinks those tools are going to get better as the entire world has run a beta test in the past few months on what works and what doesn’t work.

Revival of distressed M&A?

Morshäuser is still optimistic about (near) future M&A. He sees the following relevant elements. There still is a lot of money (‘dry powder’) in the market. In addition, private equity has not suffered large losses so far. On the seller’s side there is pressure obviously to pursue the outlined commercial strategy. At the moment M&A has slowed down, but Morshäuser also sees new strategic opportunities rising, perhaps not as fast as a year ago, but these will come again. According to Morshäuser, we will get a good M&A market at least within 12 to 18 months. Such increased M&A activity will also stabilise, in his view. That will be supported by a clean-up of competition in the markets. Morshäuser expects that we will get a lot of insolvencies. We are not seeing them yet, at least not in Germany, because there is a postponement of filing duties of the management of German companies. As a consequence, we will have a later wave of insolvencies, says Morshäuser, in particular in the automotive supplier industry, airlines and travel. Starting from late autumn he expects a wave of distressed deals. This will be accompanied by normal M&A transactions with strategic drivers. Morshäuser thinks that the outlook is not so bad as others say.

            Okazaki agrees with Morshäuser and also expects a wave of distressed and bankruptcy-related transactions. In Japan the hotel and real estate industries are tremendously affected by the pandemic. A lot was invested due to the 2020 Olympic Games, which have been postponed. That will backfire on a lot of companies. Another example is industries that have a supply chain which is disrupted by the pandemic, such as the automotive industry. Okazaki says that we can expect many supply-chain consolidations and acquisitions of suppliers.

Will we start drafting different contracts?

Due to the existing uncertainty, Okazaki expects that clients may prefer a simpler, cleaner transaction with limited legal costs, even if that approach results in lower prices, as opposed to more complex deals with earn-outs and higher prices. Okazaki says it is important to understand what the client desires and to draft accordingly. Distressed deals have higher risk of fraud and other challenges. Acquiring assets for less than the fair markets price can create issues as well. The agreement between seller and buyer typically cannot address those risks, so we may have to consider, for example, creating good records during the negotiation phase for a fair price, Okazaki says. He thinks sometimes it may even be necessary to involve the creditors of the target as well.

            Tornovsky agrees. She says it is most important now to pay attention to the business side of a deal. When we are drafting purchase agreements we should focus on reps and warranties related to business, assets and operations and ask for confirmation thereof on the closing date. Also, lawyers should discuss and address potentially unexpected events more openly, according to Tornovsky. MAC clauses will continue to be important, usually allowing the buyer to terminate the agreement, with or without payment of termination fees, or to request price revision or indemnification. According to Tornovsky, it is important to analyse any thresholds for the application of the MAC clause, such as monetary values or percentage of business deviation. Also, she says we should discuss in greater detail any events that affect the business as a whole and incorporate solutions for this in the agreement, such as termination rights or price revisions. Tornovsky expects greater scrutiny in the due diligence process, as well as in the writing of reps and warranties, especially those related to the description of the companies’ assets, operations and business. This can be the reason not to close the deal or to renegotiate the purchase price or create rules for compensation after the conclusion of the deal.

Does Covid-19 disrupt the disruptors, such as Airbnb?

Melwani thinks one cannot say that in general. There will certainly be disruptors that now are being hit very heavily, such as travel-related companies. Such companies are not going to be active right now. Yet other parties, such as Zoom, have seen their turnover skyrocket. According to Melwani, we will see many new disrupters now.

Done deals

Renegotiating earn-outs

All the uncertainly created by the Covid-19 outbreak is causing buyers and sellers to discuss how the crisis may affect their existing earn-out arrangement, Tornovsky says. Sellers that negotiated an earn-out in a business that has been affected financially may need to seek more security from the buyer. Sellers that have seen their earn-outs melting down as a result of the crisis may make an appeal for unforced and unpredictable circumstances, as a last resort. They then could claim that the earn-out should be applied on a normalised basis by eliminating the effects of the crisis on the target businesses. Whether such an appeal can be successful is to be decided on a case-by-case basis. Tornovsky mentions the aspects that could be considered, such as: if the earn-out provision was discussed before or after the outbreak; if there was any knowledge of the pandemic; the terms of the earn-out period; and how the results of the business have been affected. Based on these uncertainties parties can also consider adjusting the earn-out to include a specific arrangement that deals with the consequences of Covid-19, for example, by extending the term of the earn-out period. Another option could be the possibility of including an early earn-out payment in certain events or circumstances. Tornovsky says the pandemic is a new reality for many businesses with a potential long-term impact.

            Martin considers earn-outs to be a kind of partnership between the seller and the buyer. In a situation such as this the sellers need to be kept incentivised because they are running the business and also want be sure that their earn-out payment is maximised. Extending the terms of the earn-out is an obvious thing to look at. The counter side of that for the buyer can be that they are going to be restricted in (re)organising the target’s business for a longer term, requiring the sellers’ consent. If sellers and buyers are going to sit down and recast their earn outs, we, the lawyers, are going to follow up on that with our drafting.

Increase in M&A-related litigation

It is obvious that we will see an increase in M&A-related litigation in the next few months, Morshäuser says, for two reasons. First, deal teams now have more time to focus on what has happened in the past two or three years. Second, and even more importantly, there now can be an opportunity to grasp some value litigating a done deal when you are not hunting a new deal. Even a well-negotiated transaction in a seller-friendly market can now face a voluntary breach of obligations and experience possibilities to crack liability limitations. According to Morshäuser, normally one out of 10 to 15 deals leads to M&A-related litigation. This proportion is clearly higher now and there will be more assessment of done deals in order to try to get some value back.

            According to Melwani, earn-outs are always subject to some level of scrutiny and are now likely to be even more. He says we also are going to see more reviews of representations when the indemnification period is coming to an end. This was already common for us as attorneys, but may become even more important now, when the target’s business has not developed as envisaged, due to Covid-19. Melwani expects that we will review that more carefully over the next 12 to 24 months.

Closing remarks

To a question from the audience, Martin replied that we may see more break fees in the near future. Concluding the webinar, he stated that most lawyers will be working in the coming months on the things we have discussed. It is good to hear that not all of us are pessimists and that the deal flow can be expected to pick up. However, we will see that the shape of the market will change, to a buyer’s market, with distressed M&A and increased M&A litigation.

You can watch the webinar here: /Infected-Deals